Monthly Archives

October 2023

The quest for real income

By | Investments, Savings

Base interest rates have increased sharply over the last 18 months, as Central Banks aim to tackle high levels of inflation. As a result, interest rates on cash deposits have increased and those who look to produce an income from savings and investments can now generate relatively healthy levels of interest from deposit accounts.

On the face of it, cash is a risk-free investment, as the initial cash balance deposited does not fluctuate in value; however, the hidden risk in holding cash is the eroding impact of inflation. Let’s look at a typical savings account that is paying 4% annual interest before tax, which was opened one year ago. At face value, holding a deposit in this account will have earned 4% return and you will still hold your capital value. The hidden risk is that the real value of the cash deposited – i.e. adjusted for inflation – will have fallen. At the time of writing, the rate of UK inflation over the last 12 months has been 6.7%, which means that the amount deposited will be worth 2.7% less in real terms than when the account was opened. There are other risks of cash too, as the highest paying accounts restrict access to your money, and attention needs to be paid to the limits afforded by the Financial Services Compensation Scheme.

As we move into 2024, we expect interest rates to fall as inflationary pressure eases further, and the eye-catching rates on offer now may be a distant memory in twelve months’ time. This leaves investors who are holding cash needing to find another home as a way of generating income. This is where Equity Income investments have a real advantage over time, and as part of a diversified portfolio, can look to generate an attractive and rising income yield.

Look to dividend income

Part of the return from holding Equities are the regular distributions of excess profits, in the form of dividends. Most mature companies declare dividends to shareholders at regular intervals, and a company that enjoys a strong performance may well look to increase its’ dividend payments over time, which could potentially offset the effects of inflation.

There are a number of global stocks that have a track record of increasing dividends year on year, with the likes of Coca- Cola, IBM and Johnson and Johnson being prime examples of US listed global companies who have consistently raised their dividends each year for the last 25 consecutive years. The UK also has a smaller list of companies who have consistently raised their dividends, such as British American Tobacco and Diageo.

Dividend income is only one part of the potential return that can be achieved from holding Equities, as holding company shares can also offer scope for capital gains over time. Whilst Equities will introduce short-term volatility – which is not a feature of cash accounts – the long-term track record of returns generated by Equities markets highlights the capacity for Equities to significantly outperform returns achieved from cash deposits.

Spreading the risk

Dividends are, however, not guaranteed, and by holding individual Equities you introduce stock-specific risk. Changes in the fortunes of the company in which shares are held can not only impact the share price, but also the potential for dividend growth. Indeed, a company that begins to struggle may look to cut its’ dividends, or cancel it altogether.

As a way of mitigating this risk, we would suggest that holding Equity Income funds is a more appropriate way of gaining access to companies that pay an attractive dividend stream. This can help avoid the potential for issues with one particular company or sector having too great an impact on the overall fund value. Whilst there are a limited number of passive investments that specifically target stocks with increasing dividends, the majority of Equity Income funds are actively managed. This is where a manager or management team will look to select positions and build the portfolio, with a view to holding companies that offer an attractive and increasing dividend yield, and good prospects for capital growth over the longer term.

Equity Income funds cover most geographic areas of the World, providing access to dividend producing companies from the UK, US, Europe and Far East. There is also a wide range of Global Equity Income funds, where the fund manager can select the most appropriate positions from anywhere in the World.

As the performance of an actively-managed Equity Income fund relies on the skill of the manager, it is important to select the right fund – or blend of funds – to seek out the best performance. The level of income, and overall return, achieved from within the Global Equity Income sector can vary significantly from the best to worst performance over time, and this is where careful analysis of the fund, portfolio strategy and management style are crucial. The FAS Investment Committee regularly meets with leading fund managers from all sectors, including those who manage Equity Income funds. These regular meetings strengthen our quantitative approach to fund selection, so that we can truly understand the methods and rationale behind the portfolio selection process.

Equities as part of a diversified portfolio

It is important to point out that Equity Income funds are one of a range of different options for those seeking an income from their savings or investments. Cash deposits absolutely have a place in most sensible financial plans; however, the amount held in cash needs to be considered carefully, as the hidden eroding impact of inflation over time can easily eat into the real value of deposits.

Speak to one of our experienced advisers to discuss the options to generate an income.

pension options

Navigating the options at retirement

By | Pensions

Individuals reaching the point at which they want to access a defined contribution pension are now faced with a wider range of options as to how to draw a pension income. The Pension Freedom rules announced by George Osborne in 2014 certainly re-wrote the pension rulebook. From April 2015, those holding a defined contribution pension and aged over 55 have the option of using their pension to purchase an annuity, accessing their pension flexibly to move into Flexi-Access Drawdown or take lump sums. At the time, the new rules were revolutionary, but with the increased range of options, pension holders faced a more complex decision when deciding how best to access their pension.

Eight years on from the introduction of pension freedoms, deciding the best way to access a defined contribution pension remains a difficult decision, which can have far-reaching consequences. For this reason, seeking independent financial advice at this point can assist in reaching the right decision for your circumstances.

Tax Free Cash

It is usually the case that 25% of the value of a defined contribution pension will be available as Tax Free Cash. Many choose to take their Tax Free Cash in one lump sum, which can be used to pay off existing debts or pay for discretionary expenditure. The Tax Free Cash could also be invested, and generate further income from the lump sum payment. An alternative that may not be immediately apparent is the ability to draw Tax Free Cash over a period of time, rather than in a single payment. Depending on the overall retirement strategy, this could be an effective way of generating a tax-efficient “income” through regular Tax Free Cash payments.

Income options

Any amounts drawn above the available Tax Free Cash amount will be liable to Income Tax, and this is where careful consideration is needed in respect of the options available, to find the most appropriate method for your circumstances. For many, using a Drawdown approach can provide a flexible way of providing a retirement income. You can draw an income that suits your requirements, and this can be adjusted as your circumstances change. In addition, any funds remaining in Drawdown at death can normally be paid to your nominated beneficiaries, and the enhanced treatment of drawdown plans on death is one of the major benefits of a Drawdown approach.

Funds in Drawdown need to stay invested and this is both an opportunity and a risk. If pension investments perform well, you could potentially grow the value of your pension at a faster rate than the amount taken via Drawdown; however, if investments do not perform as expected, the pension pot could be depleted, and income payments could stop. These risks can be mitigated by selecting an appropriate rate of withdrawal that doesn’t place excessive pressure on the investment fund and ensuring that pension investments perform well.

The second option is to use the pension fund to purchase an annuity. This is where the remaining pension fund is swapped for a guaranteed income, usually for life. This guarantee provides certainty that the payments will continue no matter how long you live, or how markets are performing. Annuities provide a range of options that allow pension payments to increase each year, thus giving some protection against inflation, and potentially providing an ongoing pension for a surviving spouse in the event of death of the annuity holder. It is, however, important to understand that any additional options selected will reduce the initial payment amount.

The key drawback of an annuity is that once the payments start, you cannot cash in the annuity or alter the terms. This is a critical decision, as you will not be able to adapt your pension income to any change in circumstances. Furthermore, if annuity rates rise in the future, annuities in payment will not benefit from the increase.

Most annuities are arranged on a whole life basis, but there are options to arrange an annuity for a fixed period of time. Depending on the options selected, this can provide a return of capital at the end of the fixed term.

The third and final option is to take a lump sum payment. This is where part or the whole of a pension is drawn as a lump sum, with the first 25% of the payment being taken as Tax Free Cash and the remainder being liable to Income Tax. The major drawback of this approach is that drawing funds in a lump sum will provide no ongoing income, and in addition, the lump sum payment is made in a single Tax Year, which can have adverse Tax implications.

A further element to consider is that you do not have to adopt the same approach with the whole of a defined contribution pension. You can adopt one or more of the pension income options to find the right balance for your personal circumstances.

Which approach is right?

The short answer is that all of these options could be appropriate, depending on your needs, objectives and wider financial planning considerations. This is why seeking personalised, independent advice can help you work through the options and begin to establish a plan that works best for you. A further complication is that not all pensions provide access to every option available under the Pension Freedom rules. It may, therefore, be a wise decision to consolidate or transfer pensions prior to retirement in order to benefit from the whole range of options available, and also access a wider range of investment fund options and competitive terms.

Speak to one of our experienced advisers, to start a conversation about your existing pension arrangements, and the options open to you when deciding how to draw an income in retirement.

Graphic of a notebook resting on a keyboard alongside a pen, with 'Make A Will' written inside

The risk of not writing a Will

By | Financial Planning

According to recent research carried out by Canada Life, half of the UK population has not made a Will. Whilst uptake in the older generations is understandably higher, one in three people aged over 55 do not have a Will in place. These statistics are alarming, as dying without a Will can place an additional burden on loved ones at a difficult time. Where a Will has been left, this usually provides clear instructions, including such matters as funeral arrangements, or how possessions are to be distributed, which can ease the burden on family members. Dying without a Will also leaves no named executor to deal with the estate, and family members or other individuals will need to decide amongst themselves who will be appointed as administrator.


Intestacy rules

Many are also not aware of potential issues that can arise by relying on the laws of intestacy, which are a standard set of legal rules that apply in England and Wales if an individual dies without having made a valid Will.

For those who are married, or in a civil partnership, the surviving spouse or civil partner will receive the full value of the estate, unless there are surviving children. In this instance, the surviving spouse or civil partner will receive the first £322,000 of the estate and an absolute interest in one-half of the remainder above this level. The other half is divided equally between surviving children.

For those who are not married or in a civil partnership, the situation is even more complicated.  If the deceased had children, they receive everything split equally between them. For those without children, assets first pass to any surviving parents, then to siblings (if parents are deceased), then to grandparents (if alive), and then to wider blood relatives, such as aunts and uncles. Where an individual dies without any surviving blood-related relatives, the estate is deemed to be Bona Vacantia, and assets are passed to the Crown.


Modern life

The laws of intestacy are particularly complicated, and not widely understood. Indeed, couples that have lived together for many years but are not married or in a civil partnership, can often wrongly assume that this affords each other protection under the law. It is crucial to remember there is no such thing as a “common-law partner” under UK law, and in this situation, an unmarried partner of an individual dying intestate would not be entitled to anything under the intestacy rules.

As financial planners, we see this as a key risk that many are exposing themselves to unnecessarily. The best-laid financial plans for the future could be changed in an instant by the death of a partner who hasn’t made a Will and can leave surviving partners in financial difficulty at a time of great distress. For example, this could mean the unmarried partner being forced to move out of the family home, or funds being left to an estranged spouse. It could also lead to investments and savings being left to surviving blood relatives of the deceased partner.

Making a Will can also deal with important aspects such as guardianship of children, and how funds that children inherit are dealt with. Whilst the legal age of majority is 18, many would consider this too young an age to inherit assets. It may be a good idea to consider whether this should be delayed to, say, 21 or 25 when the beneficiary is potentially more financially aware and in a position to use the funds wisely for further education costs, or a house deposit.


Business owners at risk

Irrespective of the business interest you hold, not holding a valid Will can have serious implications in the event of the death of a sole trader, partner, or director. This could mean that the business assets could be passed to someone who may have no interest in running the business or lack the necessary ability, leaving the business at significant risk. It could also lead to conflict and disputes amongst business partners.


The link to financial planning

Whilst we do not write Wills, we regularly remind our clients of the need to prepare a Will or ensure an existing Will is up to date as part of a wider review of their financial planning objectives. Not having a valid Will, or holding a Will that is out of date, could potentially undermine financial planning strategies, or potentially lead to higher levels of tax being paid.

We recommend speaking to a suitably qualified solicitor when making a Will. This should ensure that the Will is drawn up correctly to reflect your wishes, as mistakes and errors in a Will, which are usually only uncovered after the death of the individual, can lead to disputes and legal expenses in rectifying the position.


Getting over the inertia

Most people understand the importance of making a Will, though many do not see it as a priority, or feel uncomfortable thinking about their own mortality. Given the potential risks many are facing, potentially unwittingly, by not holding a valid Will, we recommend everyone takes the time to make a Will or review an existing Will to make sure that it still reflects your wishes.

Please speak to one of our experienced team here if you would like to discuss the implications in more detail.

Background illustrating bond market data

Time to revisit Bonds?

By | Investments

After the very difficult conditions for Bond investors seen last year, we are seeing growing evidence that a change in direction is now likely. This could herald an improved performance for an asset class that has struggled over the last 18 months and suggests that good opportunities exist in Fixed Interest markets at the present time. We take a closer look at Bonds as an asset class and why now may be a good time to consider Bonds as part of your portfolio.


What is a Bond?

Bonds are issued by governments and companies when they want to raise money. By buying a bond, you’re effectively loaning your capital to the government or company, and in return, they agree to pay you back the face value of the loan on a specific date, and pay you interest during the life of the Bond.

The characteristics of a known redemption date and a fixed rate of interest should mean that Bonds produce less volatility than Equities (shares) and are also more predictable. Other factors that influence the risk of a Bond include the financial strength of the government or company issuing the Bond. The more secure and financially stable the issuer, the more likely the Bond is to be repaid in full. The length of time before the Bond matures is also a key factor. Bonds that are due to be repaid in a relatively short period of time (say 5 years or less) are less volatile than those that redeem in 20 or 30 years’ time.


Why was 2022 so difficult?

Bond markets tend to do well in periods when interest rates are low, as the yield (the return offered by a Bond) looks attractive compared to the rate of interest you could obtain through a bank or building society. Last year was, of course, dominated by the sharp rise in inflation, which was caused by the aftermath of the Covid-19 pandemic and exacerbated by the Russian invasion of Ukraine. Central banks across the Western World began hiking rates from the end of 2021, in an attempt to slow the rate of inflation. Indeed, the speed at which rates increased caught many by surprise.

As interest rates rose sharply, the only way for Bonds to remain competitive with overnight money is for the price to fall, which in turn increases the yield. There was nowhere to hide within Fixed Interest markets, and whilst some protection could be found in shorter dated Bonds – in which we held good exposure throughout the last 18 months – the value of Government and Corporate Bonds fell. Whilst this led to disappointing returns last year, it does not mean that Bonds are attractively priced.


Why is the outlook brighter?

The Bank of England and US Federal Reserve have both now paused their rate hiking cycle, bringing to an end a run of successive rate increases. Whilst there remains a possibility that either or both could raise rates again, we feel this is unlikely. Firstly, we expect inflation to continue to fall over the remainder of this year and into 2024, and the speed at which inflation returns to more normal levels could be a surprise. UK inflation data in August was weaker than expected and in the US, inflation rests just above 3%.

Secondly, economic growth is likely to slow through the next 6-12 months in many Western economies. Ratings agency Fitch recently reduced the outlook for global growth next year, and the OECD projection is for the US economy to rise by only 1% during 2024. Consumer confidence is expected to weaken and the housing markets in both the US and UK are both under pressure given the impact of higher mortgage rates.

As a result, the next substantive move in interest rates may well be down. Economists and market participants are currently weighing up whether rates will be eased gradually or potentially more aggressively, depending on the pace of economic growth. Central banks are adopting a policy whereby their decisions are being led by inflation, unemployment and growth data. Should data remain strong, then there is a case to suggest that rates will only fall gradually, but in the event that data is weaker than expected, then calls will grow for central banks to take more rapid action. There is also discourse as to the timing of rate cuts, with some suggesting the first cuts could come in the first half of next year, whilst others seeing the easing cycle starting in the third or fourth quarters of 2024.

Just as increases in interest rates are generally negative for Bonds, cuts in base rates may well prove positive. At the time of writing, a 10 year US Treasury Bond is currently yielding 4.6%, which doesn’t appear overly attractive when compared to overnight interest rates available on cash deposit; however, a yield of 4.6% could look very attractive should base rates fall over the medium term, say to between 3% and 4%.


Time to revisit Bonds?

After a very difficult 18-month period, Bond prices are attractive, and we feel there is good reason to see value in Bonds at current levels. Investment Grade Corporate Bonds (i.e. those Bonds issued by companies who credit rating agencies deem to be financially stable) and Government Bonds may well see a slow re-rating, as the economic landscape changes over the coming year. Despite the fact that the default rate (that is to say the number of Bonds who fail to repay capital or interest to investors) remains low, a slowing economy could lead to an increase in defaults from more speculative Bonds.

Diversification is a key component of a successful investment strategy, and any allocation to Bonds should be balanced with other assets, according to your attitude to risk, objectives and time horizon. This is why taking advice on the correct asset allocation for your circumstances is an important step for most investors to take.

Speak to one of our experienced advisers here about the outlook for Bonds and Fixed Interest investments, and how they could fit into your investment portfolio.